Baker Hughes Continues to Ride the North American Energy Boom

Baker Hughes reports strong quarter operationally, sees strong earnings growth ahead.

Jan-e- Alam
Jan-e- Alam
Jul 18, 2014 at 10:17AM
Energy, Materials, and Utilities

North American oil services earnings started on Thursday with Baker Hughes (NYSE:BHI) and Schlumberger (NYSE:SLB) both reporting better than expected results. The rival Halliburton (NYSE:HAL) is expected to report earnings on Monday the 21st.

As pressure from shareholders increases, oil and gas companies are looking for ways to increase production at lower costs. This in turn has prompted oilfield service companies such as Baker Hughes to develop more efficient drilling technologies. Baker Hughes is taking the lead and has introduced 47 new products and services in the second quarter alone. Moreover, technologies developed in the last two years now contribute between 35%-50% of the company's revenues. 

The new Baker Hughes
Baker Hughes, the third largest global oilfield services company, has been shifting from a top-tier manufacturing company to a technology services company. However, this cultural and organizational shift should not be underestimated. The company's transition from a premier manufacturing company to an integrated services company has not been easy or seamless.

The new Baker Hughes is focusing on innovation as a culture, accelerating growth after a period of reorganization, and there is a pleasant sense of excitement about the future among the company's executives. The company now generates 35%-50% of revenues from the new technologies developed in the last few years, which is quite impressive. 

The second quarter call was another reflection of confidence in management's tone, there is no longer sense of fixing, or repairing, or reorganization. It was much more a sense of confidence and attack.

Strong North American demand
Baker Hughes continues to benefit from the unprecedented demand for its products and services in North America. The company's profit rose 47% in the second quarter and strong performance in North America is expected to continue as oil and gas producers turn to Baker Hughes' new technologies to reduce drilling time and cut costs.

BHI reported adjusted second quarter EPS of $0.92, beating consensus estimates of $0.90. It would be an understatement to say that the results were impressive as the market was expecting the Canadian breakup to have negative impact on North American margins. Instead results came in better than expected, beating consensus estimates by 2%. 

This is also the first time the U.S. strength has been able to overcome seasonal drag from Canada, driven by more rigs, more wells, and more horizontal drilling with technologies such as Production Wave and upstream chemical demand helping to drive growth.

International operations contributing record revenues
Baker Hughes also saw an improvement in earnings quality in its international operations. Following weather delays in Russia and the North Sea in the first quarter, the company registered a solid rebound in activity in Europe, Africa, and Russia. While Latin America was bit of a disappointment, Saudi Arabia and the Middle East in general provided the strongest international growth in the quarter, with international revenues broadly up 8% year over year, setting all-time revenue records.

As far as Russia is concerned, there has been no impact of any of the sanctions announced so far. Baker Hughes continues to do well in Russia and with only single-digit market share, this should only go up.

Muted reaction
Despite a strong quarter, Baker Hughes sold off following the results. While the company outperformed operationally, guiding to a very impressive 15% quarter-over-quarter increase in segment profits in 3Q14, accompanying higher tax guidance probably took away the upside.

Moreover, investors were perhaps disappointed in the forward guidance provided on the call. However, I see improving fundamentals in activity and significant improvement in technology commercialization as significant positives for Baker Hughes.

Foolish takeaway
Baker Hughes continues to benefit from strong demand in North America as oil and gas producers turn to its technologies to cut costs and reduce drilling time. Despite the market's muted reaction, I view the results positively given strong operational performance and better than expected margins in all regions except Latin America.

North American margins of 12% show that Baker Hughes is on track to meet its mid-teen margin goal in 2H14. Similarly, margin and revenue growth trends in the international business are positive too.